Report and Recommendation of the President to the Board of Directors

Project Number: 50295-003 July 2021

Proposed Grant for Second Additional Financing Republic of the Marshall Islands: Public Financial Management Project Distribution of this document is restricted until it has been approved by the Board of Directors. Following such approval, ADB will disclose the document to the public in accordance with ADB's Access to Information Policy.

CURRENCY EQUIVALENTS

The currency unit of the Marshall Islands is the United States dollar ($).

ABBREVIATIONS

ADB – Asian Development Bank COVID-19 – coronavirus disease CSO – community service obligation GDP – gross domestic product IMF – International Monetary Fund MOF – Ministry of Finance PAM – project administration manual PFM – public financial management RCU – reform coordination unit SOE – state-owned enterprise TA – technical assistance

NOTE

The fiscal year (FY) of the Government of the Marshall Islands and its agencies ends on 30 September. “FY” before a calendar year denotes the year in which the fiscal year ends, e.g., FY2021 ends on 30 September 2021.

Vice-President Ahmed M. Saeed, Operations 2 Director General Leah C. Gutierrez, Pacific Department (PARD) Deputy Director General Emma M. Veve, PARD Director Ananya Basu, Social Sectors and Public Sector Management

Division (PASP), PARD Team leader Rommel F. Rabanal, Public Sector Economist, PASP, PARD Team members Flordeliza R. Asistin, Financial Management Specialist, Portfolio,

Results, and Quality Control Unit (PAOD-PRQ), PARD Katherine M. Barrameda, Operations Coordination Officer, Office of

the Director General (PAOD), PARD Henry A. Cornwell, Counsel, Office of the General Counsel Paul Curry, Principal Operations Coordination Specialist, PAOD,

PARD Denise T. Jack, Senior Operations Assistant, Republic of the

Marshall Islands Pacific Country Office, PARD Lady Diane T. Kuizon, Operations Assistant, PASP, PARD Mairi MacRae, Social Development Specialist (Gender and

Development), PASP, PARD Emma Rita Ramona J. Nava, Associate Project Analyst, PASP,

PARD Ellen Paul, Senior Country Officer, Republic of the Marshall Islands

Pacific Country Office, PARD Maria Carina A. Tinio, Associate Economics Officer, PASP, PARD Peer reviewer Aekapol Chongvilaivan, Economist (Public Finance), Public

Management, Financial Sector, and Trade Division, Southeast Asia Department

In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS

Page PROJECT AT A GLANCE I. THE PROPOSAL 1 II. THE PROJECT 1

A. Rationale 1 B. Project Description 5 C. Value Added by ADB 6 D. Summary Cost Estimates and Financing Plan 7 E. Implementation Arrangements 7

III. DUE DILIGENCE 9 A. Economic and Financial Viability 9 B. Sustainability 9 C. Governance 9 D. Poverty, Social, and Gender 10 E. Safeguards 10 F. Summary of Risk Assessment and Risk Management Plan 11

IV. ASSURANCES 11 V. RECOMMENDATION 11 APPENDIXES 1. Revised Design and Monitoring Framework 12 2. List of Linked Documents 15

Project Classification Information Status: Complete

PROJECT AT A GLANCE

Source: Asian Development BankThis document must only be generated in eOps. 06052021115409719150 Generated Date: 10-Jun-2021 13:47:49 PM

1. Basic Data Project Number: 50295-003Project Name Department/Division PARD/PASP

Country Executing Agency Ministry of Finance, Banking and Postal Services

Recipient

Country Economic IndicatorsPortfolio at a Glance

Public Financial Management Project (Second Additional Financing) Marshall Islands, Republic ofRepublic of the Marshall Islands

https://www.adb.org/Documents/LinkedDocs/?id=50295-003-CEIhttps://www.adb.org/Documents/LinkedDocs/?id=50295-003-PortAtaGlance

2. Sector Subsector(s) ADB Financing ($ million)Public sector management Public expenditure and fiscal management 1.60

Reforms of state owned enterprises 0.40

Total 2.00

3. Operational Priorities Climate Change InformationAccelerating progress in gender equality

Strengthening governance and institutional capacity

GHG reductions (tons per annum) 0.000Climate Change impact on the Project

Low

ADB Financing

Adaptation ($ million) 0.00

Mitigation ($ million) 0.00

Cofinancing

Adaptation ($ million) 0.00

Mitigation ($ million) 0.00

Sustainable Development Goals Gender Equity and MainstreamingSDG 1.a, 1.bSDG 5.5, 5.aSDG 16.6

Some gender elements (SGE)

Poverty TargetingGeneral Intervention on Poverty

4. Risk Categorization: Low.

5. Safeguard Categorization Environment: C Involuntary Resettlement: C Indigenous Peoples: C

.

6. Financing

Modality and Sources Amount ($ million)

ADB 2.00

Sovereign Project grant: Asian Development Fund 2.00

Cofinancing 0.00

None 0.00

Counterpart 0.30

Government 0.30

Total 2.30

Currency of ADB Financing: US Dollar

I. THE PROPOSAL 1. I submit for your approval the following report and recommendation on a proposed grant to the Republic of the Marshall Islands (RMI) for the second additional financing of the Public Financial Management Project.1 2. Since 2017, the Asian Development Bank (ADB) has been supporting the Government of the Marshall Islands through a project grant to strengthen public financial management (PFM). As with the project’s first additional financing in 2019, the proposed second additional financing will scale up the scope of the ongoing project and extend its benefits by supporting the Ministry of Finance (MOF) in prioritizing and implementing further PFM reforms.2 To allow for the additional activities, the conclusion of the project’s implementation period will be extended from 31 December 2021 to 30 June 2024.

II. THE PROJECT A. Rationale 3. Development challenges compounded by the pandemic. The RMI is a small island developing state in the North Pacific. As one of the lowest-lying atoll nations globally, climate change risks are particularly heightened. The RMI receives grants averaging 18.4% of gross domestic product (GDP) through its Compact of Free Association with the United States.3 Strict travel restrictions and quarantine requirements since the onset of the coronavirus disease (COVID-19) pandemic have helped detect all four positive COVID-19 cases at the border but have also damaged economic activity. The prolonged border closure contributed to successive economic contractions. Following a decline of 5.5% in fiscal year (FY) 2020, the economy is projected to contract by a further 1.4% in FY2021, while exports and transshipment related to fisheries, and construction activity remain subdued.4 Domestic purse seine fishing and tuna loining operations declined by about 30% in FY2020 and are expected to remain below pre–COVID-19 levels in FY2021.5 A recovery to 2.5% growth is anticipated in FY2022 when progress in COVID-19 vaccinations is expected to enable a resumption of business activity and a possible reopening of borders.6 4. Continued need for public financial management reforms. The RMI's 2012 public expenditure and financial accountability assessment (the latest available) pointed to significant weaknesses in the PFM framework.7 The International Monetary Fund (IMF) highlighted the priority areas for improving PFM, such as the legal and policy framework, budgeting framework,

1 ADB. Marshall Islands: Public Financial Management Project. 2 ADB. Marshall Islands: Public Financial Management Project (additional financing). The second additional financing

is included in ADB. 2020. Country Operations Business Plan: Eleven Small Pacific Island Countries, 2021–2023. Manila.

3 In August 2019, the United States announced the start of negotiations to extend the Compact. Negotiations proceeded through 2020, but the status of Compact grants remains subject to finalization.

4 ADB. 2021. Asian Development Outlook 2021. Manila. 5 Graduate School USA. 2020. Assessing the Impact of COVID-19 on the Marshall Islands Economy. Economic

Monitoring and Analysis Program (EconMAP) Technical Note. Honolulu. A requirement for ships to spend at least 14 days at sea prior to entry is limiting transshipment activity in Majuro, the world’s busiest tuna transshipment port.

6 The Vaccine Tracking System of the United States Centers for Disease Control indicates that, as of 6 July 2021, the RMI had received a total of 51,300 doses, and about 35.3% of the adult population is fully vaccinated.

7 Government of the Marshall Islands. 2012. Public Financial Management Performance Report and Performance Indicators (Final Report). Majuro.

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accounting system, fiscal reporting, and cash management.8 Since FY2012, the RMI’s profile of domestic resource mobilization has shifted toward nontax revenues, which comprised about 57% of own-revenue collections during FY2016–FY2018, up significantly from only about 20% prior to FY2012.9 The RMI’s PFM Reform Roadmap 2014–2016 includes a component on strengthening the management of nontax revenue.10 A 2017 progress report on the road map also prioritized stronger management of nontax revenues to ensure that additional resources are utilized efficiently, including by avoiding parallel increases in recurrent spending during windfall revenue periods.11 Moreover, although the government has made substantial progress in developing the National Planning Framework and laying the foundations for performance-based budgeting nationally, cascading these initiatives to local government units will help improve the efficiency of subnational public spending and service delivery as well. 5. Fiscal risks from state-owned enterprises and contingent liabilities. Although the RMI’s public debt stock fell steadily from 85.2% of GDP in FY2000 to 31.5% in FY2019, about a third of the outstanding debt is borrowing by state-owned enterprises (SOEs) with government guarantees.12 SOEs depend on government support—subsidies to the RMI’s 11 active SOEs totaled $15.5 million (7.3% of GDP) in FY2017, before easing slightly to $13.7 million (6.2% of GDP) in FY2018. Contingent liabilities also arise from the Marshall Islands Social Security Administration. The gap between benefit payments and contributions amounts to about $3 million annually, and pressures will only increase in the longer term (footnote 8). The latest available estimates also show that unfunded liabilities are more severe for the Marshall Islands Social Security Administration than for other social security funds in the North Pacific.13 6. Acute capacity constraints. Structural challenges stemming from the RMI’s geographic constraints, exposure to external shocks, and heavy reliance on development assistance translate into thin capacities for effective governance. Given a high turnover among senior staff—partly because of open opportunities for labor mobility to the United States as part of the Compact—and with junior staff often underqualified or lacking experience to perform their functions adequately, MOF continues to require long-term institutional capacity development to implement the PFM and SOE reforms effectively. The ministry lacks a specialized nontax revenue unit for tracking and forecasting collections, particularly of fishing license fees (para. 4). The resulting lack of a medium-term perspective and policy for expenditure smoothing contributed to large unplanned increases in public spending backed by revenue rises prior to COVID-19. Also, weak frameworks and capacities to monitor and control contingent liabilities translated into mounting fiscal risks (para. 5). Capacity constraints are even more pronounced in local governments, where limited budgetary and human resources hamper efficient service delivery. Several development partners—including ADB, the World Bank, the IMF's Pacific Financial Technical Assistance Centre, and the United States—are assisting in designing and implementing PFM reforms. MOF requires long-term on-the-ground support to coordinate this assistance.

8 IMF. 2018. Republic of the Marshall Islands 2018 Article IV Consultation Staff Report—Press Release; Staff Report;

and Statement by the Executive Director for the Republic of Marshall Islands. IMF Country Report No. 18/270. Washington, DC.

9 Since the full implementation in 2012 of a regional vessel day scheme, the RMI's collection of fishing license fees increased to an average of $20.6 million (10.0% of GDP) during FY2012–FY2019, from $1.6 million (1.1% of GDP) on average during FY2004–FY2011. More details are in the Sector Assessment (Summary): Public Sector Management (accessible from the list of linked documents in Appendix 2).

10 Government of the Marshall Islands. 2014. Public Financial Management Reform Roadmap 2014–2016. Majuro. 11 Government of the Marshall Islands. 2017. Public Financial Management Reform Roadmap Progress Report II.

Majuro. 12 Further details are in the Sector Assessment (Summary): Public Sector Management (accessible from the list of

linked documents in Appendix 2). 13 ADB. 2020. North Pacific Economies in Asian Development Outlook 2020. Manila.

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7. Ongoing project. On 13 October 2017, ADB approved the original project for $2.0 million (footnote 1). The original project supports strengthening MOF's institutional capacity to help it implement the PFM and SOE reforms effectively. On 17 September 2019, ADB approved an additional financing of $0.5 million to scale up and consolidate activities under the original project and allow for further PFM and SOE reforms to be implemented. The ongoing project’s current closing date of 31 December 2021 will be extended to 31 December 2024 with the proposed second additional financing. 8. A reform coordination unit (RCU) was established under the original project as a pool of long-term consultants based in Majuro to provide on-the-ground support to MOF.14 The RCU is adequately staffed and fully functional, providing day-to-day advice, assistance, and capacity building to government counterparts. Under the ongoing project, the RCU updated the PFM Reform Roadmap (footnote 10) and contributed to 12 of the 30 broad reform areas in the updated version.15 Among the key recent achievements of the RCU is the development of a draft fiscal responsibility and debt management bill to help underpin longer-term fiscal sustainability, identification of necessary institutional, systems, and capacity upgrades to facilitate tax reform, and continuous updates of the RMI’s medium-term budgeting and investment framework. 9. Human resources development is a crosscutting enabler of reform implementation. The RCU reviewed MOF's positions and related job descriptions to inform the preparation of organizational reforms. It also helped strengthen performance management by (i) introducing standardized performance criteria and performance evaluation tools for MOF employees, (ii) building the capacity of MOF's human resources staff to conduct results-oriented performance reviews that link staff performance to organizational performance, and (iii) introducing a performance-based management framework. To support longer-term and sustainable capacity development, the RCU is partnering with the College of the Marshall Islands to design and deliver a tailored training course on government accounting for young Marshallese graduates. 10. Progress was made in SOE reforms as well. The establishment in 2018 of an SOE monitoring unit in MOF, which was further bolstered by the creation in 2019 of an assistant secretary position to oversee the unit, helped MOF complete draft agreements on community service obligations (CSOs) with four SOEs.16 To rationalize inefficient annual subsidies, the cabinet authorized the switch to formal performance-based CSO contracts for two of these SOEs. The RCU is helping empower qualified women to serve on SOE boards. As of June 2021, women occupied only 27.5% of directorships on SOE boards, although this is an improvement on the 21.5% in 2018. In response to government requests for tailored capacity building to allow women to better compete in skills-based director selection, the RCU is now providing specialized training on SOE governance skills for women. 11. Second additional financing. The project meets the eligibility criteria for additional financing. In ADB’s assessment, the ongoing project is rated performing well, based on:

14 The core group of RCU consultants, including the team leader, remained in Majuro throughout the COVID-19

pandemic. Short-term consultants on tax reforms and fiscal responsibility legislation provided support remotely. 15 Includes progress in (i) the overall PFM legal and policy framework, (ii) budgeting framework, (iii) annual reporting

by line ministries, (iv) cash management, (v) procurement management, (vi) payroll management, (vii) asset management, (viii) introduction of a performance-based management framework, (ix) management of imprest accounts of all of the embassies of the Marshall Islands, (x) external audit, (xi) aid coordination, and (xii) PFM reform communications and training. More details on the activities and progress under the ongoing project are in Summary of Project Performance (accessible from the list of linked documents in Appendix 2).

16 CSO agreements cover specific units of goods and services to be supplied legitimately by SOEs under defined terms and conditions and at stipulated prices. These terms, along with a detailed cost-of-services study, then determine the amount of annual financial support that will be required by SOEs to deliver their respective CSOs.

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(i) Satisfactory implementation progress. Cumulative contract awards total $2.475 million (99.0% of ADB financing) and cumulative disbursements total $2.215 million (88.6% of ADB financing) as of 21 June 2021. This is against time lapsed from project start to scheduled completion of 85.0%.

(ii) Delivery of expected outputs on track. Project implementation is on track to deliver all expected outputs. Under output 1: MOF’s institutional capacity to implement the PFM Reform Roadmap 2014–2016 of the RMI strengthened, the RCU updated the road map and contributed to advancing at least 12 (against a target of 6 in the original project’s design and monitoring framework) of the 30 broad reform areas in the updated road map (para. 8). The RCU also conducted 30 capacity building sessions during 2018–2020, where women made up 52% of the participants. Under output 2: MOF’s institutional capacity to implement SOE reforms strengthened, an SOE monitoring unit was set up, and the CSOs of four SOEs were defined and costed (para. 10), as stipulated in the original project’s design and monitoring framework.

(iii) Satisfactory compliance with fiduciary and safeguard policy requirements. The project is classified as category C for environment, indigenous peoples, and involuntary resettlement because it provides only advisory services. Each safeguard covenant item of the ongoing project is complied with. The ongoing project also complies with the prevailing financial management covenant.

(iv) Successful management of risks. The risk mitigation measures of the ongoing project are being implemented satisfactorily. These include the delegation of consultant selection to ADB, subject to the government’s final decision on their engagement. The government actively encourages suitable candidates to apply for sustained availability of support. Regular development partner coordination meetings ensure the timely provision of complementary technical assistance (TA).

(v) Project performance rating on track. Overall, the ongoing project is rated on track under ADB’s project performance rating system. The audited financial statements, covering FY2019–FY2020, were received on 9 April 2021.

12. Another additional financing is a suitable modality because the proposed activities remain strongly linked to the design of the ongoing project, while contributing to the same outputs and outcomes relating to improved PFM. As demonstrated by the first additional financing, this modality adequately supports the goal of scaling up the project’s scope by expanding the reform areas. The implementation arrangements also remain unchanged, while additional individual consultants are expected to be recruited as part of the RCU, under the supervision of MOF. The overall project’s intended impact is aligned with the good governance pillar of the RMI's National Strategic Plan 2020–2030.17 The second additional financing is also consistent with ADB’s Pacific Approach, 2021–2025, which serves as the overall country partnership strategy for the 11 small Pacific developing member countries, including the RMI; it specifically prioritizes PFM improvements as a means to prepare for and respond to shocks, and to build resilience.18 It also aligns with Strategy 2030’s operational priority 6—strengthening governance and institutional capacity, particularly in small island developing states—by building capacities to implement PFM and SOE reforms; and with operational priority 2—accelerating progress in gender equality.19

17 Government of the Marshall Islands. 2020. National Strategic Plan 2020–2030. Majuro. 18 ADB. 2021. Pacific Approach, 2021–2025. Manila. 19 ADB. 2018. Strategy 2030: Achieving a Prosperous, Inclusive, Resilient, and Sustainable Asia and the Pacific.

Manila.

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B. Project Description 13. The overall project’s intended impact will remain the same: more effective governance achieved in the RMI. 20 The target outcome continues to be improved PFM, to be achieved by sustaining efforts to strengthen MOF’s institutional capacity for (i) prioritizing and implementing the PFM Reform Roadmap, and (ii) designing and implementing SOE reforms.21 14. Output 1: MOF’s institutional capacity to implement the PFM Reform Roadmap strengthened. To support the achievement of the first output and advance the intended outcome of further PFM improvements, the RCU will focus on three additional reform components in the PFM Reform Roadmap under the second additional financing:

(i) Improving the management of nontax revenue. The project will support the establishment of a nontax revenue unit at MOF responsible for (a) formulating policies and operating guidelines for nontax revenues; (b) developing databases and other information systems to strengthen collection forecasts as inputs to the annual budget process; and (c) conducting a comprehensive review of fees and charges to enable the formulation of a phased price adjustment and rebasing plan.

(ii) Strengthening control over contingent liabilities. With RCU support, the SOE monitoring unit will prepare a policy paper on strengthening the management of contingent liabilities arising from SOE operations. The unit will help review and refine the applicable policies, e.g., those on loan guarantees to local governments and SOEs, and on the issuance of indemnities through the social security scheme. The revisions will serve as a critical input to the development of draft legislation aimed at containing the fiscal risks from the accumulation of contingent liabilities by local governments and SOEs, and from unfunded social security liabilities.

(iii) Introducing performance-based budgeting for local governments. The project will expand its support to include capacity building for local governments and their adoption of performance-based budgeting to align operational budgets with the National Strategic Plan and applicable sector plans (para. 4). This is a natural extension of the ongoing work toward national performance-based budgeting, which included setting key performance indicators for line ministries linked to the National Strategic Plan. Similar key performance indicators will be developed subnationally to support the PFM Reform Roadmap’s aim of improving local governments’ financial management. The project will introduce gender-sensitive frameworks for performance-based budgeting across local government units to ensure that community-based service delivery meets women’s needs adequately.

15. The second additional financing will also support further progress in areas already covered by the ongoing project. Building on initial work on tax reform (para. 8) supporting the PFM Reform Roadmap’s component on improving tax administration, the focus will be on capacity building for the tax office and finalization of the government’s tax reform agenda. The additional financing will support the design of legislation to (i) replace import taxes, gross revenue taxes, and local sales taxes with a consumption tax, business net profits tax, excise taxes, and revised tax rates for wages and salaries; and (ii) implement new business processes and a new digital revenue management system to help administer the new tax system. A key component of this second additional financing is to support extensive consultation with all stakeholders, as well as close coordination with development partners to facilitate the implementation of the new tax policies.

20 Government of the Marshall Islands. 2014. Republic of the Marshall Islands National Strategic Plan 2015–2017.

Majuro; and Government of the Marshall Islands. 2020. National Strategic Plan 2020–2030. Majuro. 21 The design and monitoring framework is in Appendix 1.

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16. Output 2: MOF’s institutional capacity to implement SOE reforms strengthened. The second additional financing will enable the project to sustain the reform momentum by (i) completing draft CSO agreements with five more SOEs; and (ii) progressing to formal CSO contracts with at least two more SOEs. A comprehensive assessment of CSO costs will help identify, and eventually phase out, the portion of subsidies that effectively finance lingering SOE inefficiencies, which will help reduce the annual transfers. Streamlined subsidies will contribute to the intended outcome of improved PFM through more efficient public spending. The RCU will continue to provide specialized training to empower women to serve on SOE boards, designed and implemented in coordination with gender champions in the Office of the Chief Secretary and the Ministry of Culture and Internal Affairs (Gender Development Division) (para. 10). C. Value Added by ADB 17. Past engagement. The project builds on previous ADB support to the RMI for progressing PFM and SOE reforms. Through two subprograms of the Public Sector Program in 2010–2012, ADB assisted the RMI in adopting and implementing reform plans to improve the performance of selected SOEs, completing a public sector workforce audit and planning exercise, and achieving specific expenditure targets.22 ADB also provided TA to support the implementation of the government’s national development plan.23 In addition, regional TA helped the RMI improve governance within SOEs and define SOE policy and legislation, develop a fiscal management model, and periodically clear audit backlogs.24 18. Lessons. ADB's previous engagement (footnote 22) highlighted the need to remove acute capacity constraints through long-term on-the-ground support, as is being provided by the RCU. Experience from the ongoing project further confirms the crucial importance of long-term capacity building and supplementation, not only to underpin reform progress but also to support MOF in the performance of its day-to-day core functions. The support for MOF is translating into broader benefits for other ongoing ADB operations for which MOF is the executing agency. Delegating the recruitment of consultants to ADB, while subject to the government's final decision on their selection and engagement, also helped ease constraints in procurement capacity and expedited the mobilization of key experts. ADB is working closely with development partners, such as coordinating efforts with the World Bank’s parallel project to upgrade the RMI's outdated financial management information and procurement systems, and holding periodic discussions with the IMF’s Pacific Financial Technical Assistance Centre. The technical capacity being built by the project can serve as a solid foundation for ADB's and other development partners' long-term engagement in public sector management in the RMI. 19. Differentiated approach. The project continues a differentiated approach to supporting public sector reforms in small island developing states that are constrained by thin capacities for effective governance, such as the RMI. This involves (i) using long-term capacity building and supplementation support primarily through consultants based in Majuro to facilitate the design, prioritization and implementation, monitoring and evaluation, and refinement of reforms; (ii) broad-based engagement while building capacity for deeper reforms; and (iii) integration with related

22 ADB. 2014. Technical Assistance Completion Report: Public Sector Program–Subprogram 1 in the Marshall Islands.

Manila; and ADB. 2014. Completion Report: Public Sector Program–Subprograms 1 and 2 in the Marshall Islands. Manila.

23 ADB. Marshall Islands: Strengthening Economic Policy and Planning: Supporting the Implementation of the National Development Plan, 2012–2015. Manila.

24 ADB. Regional: Pacific Economic Management-Enhanced Economic Management (Subproject 2); and ADB. Regional: Pacific Private Sector Development Initiative, Phase IV.

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country activities supported by ADB and other development partners to reinforce results achievement and sustain the reform momentum. D. Summary Cost Estimates and Financing Plan 20. The overall project is estimated to cost $5.15 million (Table 1). Detailed cost estimates by expenditure category and by financier are included in the project administration manual (PAM).25 The major expenditure item is consulting services to resource the RCU and SOE monitoring unit. 21. The government has requested a grant not exceeding $2.0 million from ADB’s Special Funds resources (Asian Development Fund) to help finance the project. The summary financing plan is in Table 2. ADB will finance the expenditures in relation to consulting services, and training and capacity building activities. The government will provide counterpart support in the form of staff time, office space and supplies, and exemptions from taxes and duties estimated at $300,000. No cofinancing is envisaged.

Table 1: Summary Cost Estimates

Item Current Amounta

($) Additional Financingb

($) Total

($) A. Base Costc 1. Road map implementation 2,287,002 1,784,356 4,071,358 2. State-owned enterprise reforms 431,523 405,200 836,723 Subtotal (A) 2,718,525 2,189,556 4,908,081 B. Contingenciesd 131,475 110,444 241,919 Total (A+B) 2,850,000 2,300,000 5,150,000 a Refers to the original amount and first additional financing. b Includes taxes and duties of $108,000. Such amount does not represent an excessive share of the project cost.

The government will finance taxes and duties of $108,000 (for consulting services only) through exemptions. Taxes and duties for other items will be financed by the Asian Development Bank.

c In mid-2020 prices. d Physical and price contingencies, and a provision for exchange rate fluctuation are included. Source: Asian Development Bank estimates.

Table 2: Summary Financing Plan Currenta Additional Financing Total

Source Amount

($) Share of Total (%)

Amount ($)

Share of Total (%)

Amount ($)

Share of Total (%)

Asian Development Bank (Special Funds

resources [ADF grant])

2,500,000

87.7

2,000,000 87.0

4,500,000 87.4 Government of the Marshall

Islands 350,000 12.3 300,000

13.0

650,000 12.6 Total 2,850,000 100.0 2,300,000 100.0 5,150,000 100.0

ADF = Asian Development Fund. a Refers to the original amount and the first additional financing. Source: Asian Development Bank estimates. E. Implementation Arrangements 22. The implementation arrangements are summarized in Table 3 and described in detail in the PAM (footnote 25). 23. The arrangements established for the ongoing project will be used to implement the second additional financing. MOF will continue to be the executing agency, and the RCU remains

25 Project Administration Manual (accessible from the list of linked documents in Appendix 2).

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the implementing agency. The PFM Reform Steering Committee will provide strategic oversight and guidance. The consultant recruitment process will still be delegated to ADB, but consultants will be engaged by, and report to, MOF. 24. The second additional financing is expected to allow for the renewal of the contracts of current RCU consultants to sustain the project’s support for the implementation of the PFM Reform Roadmap as well as the three additional priority components (para. 14). All current RCU consultants are performing satisfactorily, providing quality services that meet MOF’s expectations and needs. Since additionally required inputs are a natural continuation of the RCU’s ongoing work, contract extensions provide a clear advantage over renewed competition. The contracts of the RCU advisor and team members will be extended to maintain uninterrupted technical and coordination support across all reform areas. In addition, the RCU’s long-term resources will be augmented by contracting two additional financial management specialists to continue and further strengthen the unit’s support for government accounting and auditing.

Table 3: Implementation Arrangements Aspects Arrangements Implementation period August 2021–June 2024 Estimated completion date 30 June 2024 Estimated grant closing date 31 December 2024 Management

(i) Oversight body Public Financial Management Reform Steering Committee Chief secretary (chair) Secretary of finance, auditor general, attorney general, chair of the Public Service Commission (members)

(ii) Executing agency Ministry of Finance (iii) Key implementing agencies Reform Coordination Unit (iv) Implementation unit Reform Coordination Unit, 9 long-term staff: (i) 1 advisor, (ii) 1 public finance

specialist, (iii) 3 financial management specialists, (iv) 1 human resources specialist, (v) 2 accounting specialists, and (vi) 1 administrative assistant

Consulting services Individual consultant selection 205 person-months $1,846,000 Advance contracting Advance contracting for consultants Disbursement The grant proceeds will be disbursed following ADB's Loan Disbursement

Handbook (2017, as amended from time to time) and detailed arrangements agreed between the government and the Asian Development Bank.

ADB = Asian Development Bank. Source: Asian Development Bank. 25. The RCU advisor and financial management specialists will support MOF’s development of policies, systems, and institutional arrangements for the establishment of a nontax revenue unit in MOF (para. 14.i). They, along with the human resources expert—who oversees broader knowledge management and capacity building activities, while also focusing on change management initiatives—will develop and implement training on performance-based budgeting for local governments (para. 14.iii). The proposed SOE reform implementation activities will be undertaken by the current SOE reform expert, whose contract will be extended. Supported by the RCU advisor and the human resources specialist, and in close consultation with gender champions in the government, the SOE reform expert will develop training courses to upskill women and thus enable them to better compete for positions on SOE boards. The SOE reform expert will also review and refine policies to bolster the government’s control of contingent liabilities and help prepare the requisite legislation (para. 14.ii). Under the second additional financing, the RCU is targeted to have 9 long-term experts under contract, i.e., the current 7 RCU consultants whose contracts will be renewed, and 2 additional financial management specialists (para. 24) to be recruited. In selecting the consultants, preference will be given to qualified women.

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III. DUE DILIGENCE A. Economic and Financial Viability 26. Since the project involves the provision of advisory and capacity building services rather than any revenue-generating investment, standard cost–benefit and cash flow analyses to determine its economic and financial viability are not applicable. Instead, a simplified quantitative approach focusing on the second additional financing’s support for nontax revenue management is employed. Financial benefits arise from the additional fiscal space that the government can generate by controlling inefficient increases in recurrent spending, to be underpinned by improved management of nontax revenues. In turn, economic benefits derive from the productive use of this additional fiscal space through development-oriented public spending such as capital outlays or investments in education and health. Under conservative assumptions whereby the RMI’s recurrent spending on the purchase of goods and services gradually declines by the equivalent of 15.9% of GDP in FY2021 to 15.0% by FY2024, the second additional financing is shown to yield additional fiscal space of about $4.0 million, plus multiplier effects from productive public spending of at least $2.0 million, indicating solid value for money.26 B. Sustainability 27. Capacity building measures supported by the RCU, mainly by prioritizing knowledge and skills transfer when the unit works with staff from MOF and other relevant line agencies, will help ensure the sustainability of reform benefits. Necessary follow-on capacity building activities can be identified and supported by ADB in coordination with other development partners engaged in PFM reforms in the RMI. National consultants working with the RCU are also gaining skills that will help position them for potential absorption in the workforce of the national government. C. Governance 28. Financial management. An assessment prepared for MOF prior to the approval of the original project indicated that the overall pre-mitigation financial management risk is substantial. With support from the RCU established through the project, qualified staff are working closely with MOF to implement the PFM reforms and to manage the identified risks. An April 2021 update of the financial management assessment confirms that, although the overall inherent and control risks remain substantial, mitigation measures put in place through the ongoing project are proving to be successful in helping manage these risks. Under the second additional financing, ADB will continue to employ the direct payment procedures for international consultants established under the ongoing project. An advance account will be set up for the second additional financing—to be administered by MOF with RCU assistance, with a ceiling of $100,000—for small payments (e.g., training materials, workshops, and project operational expenses). MOF will facilitate the preparation of detailed consolidated project financial statements to be audited by an independent auditor acceptable to ADB, and in accordance with both the International Standards on Auditing and the government’s audit regulations. The final audit report for the ongoing project covering FY2019–FY2020 was received on 9 April 2021. 29. Procurement. Similarly, a procurement capacity assessment of MOF undertaken prior to the approval of the original project found substantial overall pre-mitigation procurement risk. The issues that could affect project procurement include (i) weak external aid coordination, (ii) MOF’s inadequate prior experience with the international procurement of consultants,

26 Economic and Financial Analyses (accessible from the list of linked documents in Appendix 2).

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(iii) absence of reliable data on procurement contracts, (iv) insufficient capacity of staff to carry out procurement, and (v) inadequate procurement documentation and monitoring. Support from the RCU is likewise helping to mitigate procurement risks. Only individual consultants will be procured under the project—their recruitment under the second additional financing will again be delegated to ADB because this has worked very well for the ongoing project—and contracts will not be complex or high-value. All procurement will follow ADB’s Procurement Guidelines (2015, as amended from time to time) and Guidelines on the Use of Consultants (2013, as amended from time to time). ADB’s Anticorruption Policy (1998, as amended to date) was explained to and discussed with the government and MOF. ADB will conduct integrity due diligence on consultants, and anticorruption efforts will continue to be discussed in the training sessions provided by the RCU, as appropriate. The specific policy requirements and supplementary measures are described in the PAM (footnote 25). D. Poverty, Social, and Gender 30. Poverty and social. ADB's 2015 assessment of socioeconomic vulnerability in the RMI estimated the basic-needs poverty incidence at 38.4% of the population (36.6% at the household level). Income poverty is greater in the outer islands than in the urban centers of Majuro and Ebeye. In 2020, ADB estimated that the poverty rate would have fallen to 29.4%–31.6% by FY2019, but the economic and social impacts of the COVID-19 pandemic are now projected to raise the poverty rate to 33.8%–35.2% by the end of FY2021. The project is designed to contribute to poverty reduction through improved PFM systems and stronger SOE management, which will reduce fiscal deficits, help build fiscal buffers to manage external shocks, and create a foundation for sustainable and inclusive economic growth. 31. Gender. As with the original project and the first additional financing, the second additional financing is classified as some gender elements. Women will not only benefit from program design elements that contribute to poverty reduction, but also from proactive gender actions. The plan to upgrade MOF’s human resources proposes the prioritization of qualified women in recruitment and promotions. The introduction of gender-sensitive frameworks for performance-based budgeting across local government units will help improve the community-based delivery of services that meet women’s needs. The overall project will continue to promote women’s empowerment through (i) targets for women’s participation in project training activities; (ii) specialized training to equip women for directorships on SOE boards; and (iii) proactive measures to increase the proportion of women in MOF's management positions, subject to qualifications. Also, the biannual progress reports prepared by the RCU will continue to include sex-disaggregated data and reporting on gender actions. E. Safeguards 32. In compliance with ADB’s Safeguard Policy Statement (2009), the project’s safeguard categories are as follows.27 33. Environment, involuntary resettlement, and indigenous peoples (all category C). No adverse environmental, involuntary settlement, or indigenous people impacts were identified, since the project involves only advisory and capacity building inputs.

27 ADB. Safeguard Categories.

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F. Summary of Risk Assessment and Risk Management Plan 34. Significant risks and mitigating measures are summarized in Table 4 and described in detail in the risk assessment and risk management plan.28

Table 4: Summary of Risks and Mitigating Measures Risks Mitigating Measures External shocks, including COVID-19 and climate change impacts, divert capacity and disrupt reforms.

ADB will monitor national, regional, and global economic developments and respond in a timely manner and in coordination with other partners to government requests for assistance during unforeseen shocks.

Non-availability of expert consultants in the required time frame stalls the reform efforts.

The government is identifying suitable candidates with appropriate experience and encouraging them to apply for RCU positions. Remuneration rates for RCU positions under the project will be set to attract high-quality consultants. The government has delegated the process of recruiting the consultants to ADB.

Lack of, or delays in, delivery of technical assistance from development partners impede reform progress.

Regular technical assistance coordination meetings will continue to be organized through the RCU to identify gaps in support and mobilize further resources to help the government prioritize, implement, and refine the updated PFM Reform Roadmap 2014–2016 of the Marshall Islands (footnote 10).

Governance risks stemming from weaknesses in institutional, financial management, and procurement capacities may undermine the sustainability of reform efforts.

RCU consultants will be funded by the project for an extended period to provide stable support. International consultant payments will be made directly by ADB, while MOF’s advance account will be used for smaller payments such as the remuneration for local consultants, to ease financial management and procurement bottlenecks. RCU national consultants are well positioned for possible absorption as regular MOF staff beyond the project’s duration, which will further support sustainable institutional capacity development.

ADB = Asian Development Bank, COVID-19 = coronavirus disease, MOF = Ministry of Finance, RCU = reform coordination unit. Source: Asian Development Bank.

IV. ASSURANCES 35. The government and MOF have assured ADB that project implementation shall conform to all applicable ADB requirements, including those concerning anticorruption measures, safeguards, gender, procurement, consulting services, financial management, and disbursement, as described in detail in the PAM (footnote 25) and grant documents. 36. The government and MOF have agreed with ADB on certain covenants for the project, which are set forth in the draft grant agreement.

V. RECOMMENDATION 37. I am satisfied that the proposed grant would comply with the Articles of Agreement of the Asian Development Bank (ADB) and recommend that the Board approve the grant not exceeding $2,000,000 to the Republic of the Marshall Islands from ADB’s Special Funds resources (Asian Development Fund) for the second additional financing of the Public Financial Management Project, on terms and conditions that are substantially in accordance with those set forth in the draft grant agreement presented to the Board.

Masatsugu Asakawa President

7 July 2021

28 Risk Assessment and Risk Management Plan (accessible from the list of linked documents in Appendix 2).

12 Appendix 1

REVISED DESIGN AND MONITORING FRAMEWORK The revised design and monitoring framework strikes out content for deletion and underlines content to be added. Impact the Project is Aligned with More effective governance achieved (Republic of the Marshall Islands, National Strategic Plan 2015–2017; National Strategic Plan 2020–2030)a

Results Chain Performance Indicators Data Sources and

Reporting Mechanisms Risks and Critical

Assumptions Outcome PFM improved By the end of 2021 June

2025:

a. Country performance assessment score for quality of budgetary and financial management increased by 0.5 points (2016 baseline: 3.0)

a. ADB annual report on the country performance assessment exercise

R: External shocks, (economic and/or climatic such as the coronavirus disease (COVID-19) pandemic and climate change, divert political and administrative attention and capacity away from reforms.

b. Number of D/D+ scores in PEFA falls by six or moreb

(2012 baseline: 21 of 35)

b. PEFA report or equivalent assessment

c. Fiscal transfers to SOEs decline to 5.9% of GDP (2015 baseline: 6.4% of GDP)

c. International Monetary Fund Article IV reports

Outputs 1. MOF’s institutional capacity to implement the PFM Reform Roadmap strengthened

By the end of 2020 June 2024: 1a. At least six 15 road map reforms implemented, as per updated PFM Reform Roadmap action plan (2017 baseline: not implemented) (OP 6.1.3)

1a. Certification by MOF (by means of cabinet orders, government decisions, MOF memoranda, as appropriate), and corroborated by development partners

R: Lack of timely availability of good consultants for the RCU undermines reform efforts. R: Lack of or delay in partner technical assistance to support the implementation of PFM Reform Roadmap or MOF's human resources upgrade plan undermines reform pace.

1b. At least three training sessions per year provided by the RCU, with women accounting for at least 35% of trainees (2017 baseline: training not provided) (OP 2.1.1) (OP 6.1.1)

1b. Biannual progress reporting by the RCU

1c. Shares of MOF male and female staff in position holding accounting, computer, or business administration degrees and/or diplomas increased (2017 baseline: 38.2% of male staff and 45.1% of female staff in position) (OP 6.1.1)

1c. Biannual progress reporting by the RCU

1d. Share of women staff in MOF management positions

1d. Biannual progress reporting by the RCU

Appendix 1 13

Results Chain Performance Indicators Data Sources and

Reporting Mechanisms Risks and Critical

Assumptions (secretary, assistant secretary, division and/or section head) increased, subject to qualifications (2017 baseline: 18.7% of staff in position) (OP 2.3)

1e. Revised fiscal responsibility bill approved by PFM Reform Steering Committee (2018 baseline: not revised) (OP 6.1.3)

1e. Committee decision

1f. Draft tax administration legislation approved by PFM Reform Steering Committee (2018 baseline: not drafted) (OP 6.1.4)

1f. Committee decision

1g. Nontax revenue unit established in MOF to formulate policies and guidelines; develop databases and information systems; review and rebase current fees and charges, among others (2020 baseline: unit not established) (OP 6.1.3)

1g. Cabinet or ministerial decision, or equivalent

1h. Policy paper prepared on the management of contingent liabilities from SOEs (2020 baseline: not prepared) (OP 6.2.3)

1h. Copy of the policy paper

1i. Draft legislation on contingent liabilities approved by the PFM Reform Steering Committee (2020 baseline: not drafted) (OP 6.1.4)

1i. Committee decision

1j. Gender-sensitive performance-based budgeting frameworks for local government units introduced (2020 baseline: none introduced) (OP 2.3.2) (OP 6.2.2)

1j. Biannual progress reporting by the RCU

2. MOF’s institutional capacity to implement SOE reforms strengthened

By the end of 2020 2024: 2a. SOE monitoring unit established in MOF and staffed (2017 baseline: not established) (OP 6.2.3)

2a. Cabinet or ministerial decision, or equivalent

2b. Report prepared, identifying and assessing legitimacy and cost of CSOs

2b. Copy of report

14 Appendix 1

Results Chain Performance Indicators Data Sources and

Reporting Mechanisms Risks and Critical

Assumptions for at least four nine selected SOEs (2017 baseline: not prepared) (OP 6.2.3)

2c. Share of women directors on SOE boards increased, subject to qualifications (2018 baseline: 21.5% of directors in position) (OP 2.3)

2c. Biannual progress reporting by the RCU

2d. Performance-based CSO contracts signed with at least four SOEs (2020 baseline: not signed) (OP 6.2.3)

2d. Copy of CSO contracts

Key Activities with Milestones 1. MOF’s institutional capacity to implement the PFM Reform Roadmap strengthened 1.1 Contract consultants under ongoing project grant by Q4 2017 (completed). 1.2 Prepare prioritized and updated action plan based on PFM Reform Roadmap by Q2 2018

(completed). 1.3 Prepare a training plan (for training to be provided by the RCU) for MOF and other relevant

government agencies by Q2 2018, including gender targets and actions (completed). 1.4 Contract consultants under first additional financing between Q4 2019 and Q1 2020 (completed). 1.5 Prepare revised fiscal responsibility bill and draft tax administration legislation by Q3 2020

(completed). 1.6 Contract consultants under second additional financing between Q3 2021 and Q4 2023. 1.7 Support the establishment of a nontax revenue unit in MOF by Q1 2023. 1.8 Roll out performance-based budgeting frameworks in local government units between Q1 2022 and

Q4 2023. 1.9 Prepare draft legislation on contingent liabilities to be finalized by Q4 2022. 1.10 Provide PFM policy and technical advice and capacity development through RCU (Q1 2018–Q2

2021 2024). 1.11 Report to MOF (and to ADB through MOF) on RCU performance by Q2 2018, Q4 2018, Q2 2019,

Q4 2019, Q2 2020, Q4 2020 biannually (Q2 2018–Q2 2024). 2. MOF’s institutional capacity to implement SOE reforms strengthened 2.1 Prepare report on CSO costs and legitimacy by Q3 2018 (completed). 2.2 Establish SOE monitoring unit within the MOF by Q3 2018 (completed). 2.3 Provide SOE training targeted to women through RCU (Q4 2019–Q4 2020 Q2 2024). 2.4 Prepare policy paper on contingent liabilities from SOEs by Q2 2022. Project Management Activities Continue regular monitoring and supervision until Q2 2024 (ADB and MOF). Manage contracts from Q4 2017 until Q2 2024 (MOF, with ADB support). Provide timely biannual progress reports until Q2 2024 (RCU to MOF, and to ADB through MOF). Carry out regular project accounting and annual audits (MOF). Inputs ADB grant: $2,500,000 4,500,000 ($2,000,000 additional) Government of the Marshall Islands (in-kind contributions): $350,000 650,000 ($300,000 additional)

ADB = Asian Development Bank, CSO = community service obligation, GDP = gross domestic product, MOF = Ministry of Finance, OP = operational priority, PEFA = public expenditure and financial accountability, PFM = public financial management, Q = quarter, R = risk, RCU = reform coordination unit, SOE = state-owned enterprise. Note: The expected values and methodological details for all OP indicators to which this operation will contribute results are detailed in Contribution to Strategy 2030 Operational Priorities (accessible from the list of linked documents in Appendix 2). a Government of the Marshall Islands. 2014. Republic of the Marshall Islands National Strategic Plan 2015–2017. Majuro;

Government of the Marshall Islands. 2020. National Strategic Plan 2020–2030. Majuro. b For the PEFA assessment and scoring methodology, please visit the PEFA resource center (https://pefa.org/). Source: Asian Development Bank.

Appendix 2 15

LIST OF LINKED DOCUMENTS http://www.adb.org/Documents/RRPs/?id=50295-003-2

1. Grant Agreement 2. Sector Assessment (Summary): Public Sector Management 3. Project Administration Manual 4. Summary of Project Performance 5. Economic and Financial Analysis 6. Summary Poverty Reduction and Social Strategy 7. Risk Assessment and Risk Management Plan 8. Contribution to Strategy 2030 Operational Priorities